Deals vs. Rules: Capturing Regulatory Burdens

The costs of excessive regulatory burdens can stifle incentives for firms to innovate, invest and grow. In recent years, aid agencies and developing countries have been stepping up efforts to reduce numerous and lengthy regulatory procedures. However, the focus on aggregate measures of regulatory burden for a country and relying on measures of formal requirements misses a lot of the action.

The World Bank has interviewed over 100,000 entrepreneurs and senior managers in over 100 countries as part of its Enterprise Surveys project. Among the measures collected is the de facto time it takes businesses to complete various interactions with the government (e.g., the time to get goods through customs, get a construction permit, or get an operating license). In the chart below, each vertical line represents a country, and the length of the line represents the distribution of time for firms to clear goods through customs. The first thing to notice is just how much variation there is – within individual countries. There are favored firms for whom it takes a couple of days to obtain permits or clear customs – and disfavored firms, for whom the wait can be weeks or even months. The variation within most countries is considerably larger than the differences in averages across countries.

The second thing to notice is that variation in how policies are actually implemented also bears little significant association with how long compliance is supposed to take. The Doing Business project provides de jure measures of regulatory compliance, if firms and officials do all of what they are supposed to do in the time required. Each country’s de facto distribution is plotted along the x-axis at the Doing Business number of days it should take to comply. At low levels of time to get things done, the de jure and de facto measures track each other fairly well; the bars follow along the 45 degree line. But the relationship quickly breaks down and the distribution of times in practice has virtually no association with the formal requirements. For countries with lengthy requirements, this may be good news as almost no firm actually faces the formal burdens on the books.

This does not mean that lengthy formal practices are costless. Rather, firms ‘pay’ through other channels. This variation in implementation is associated with greater activities on the part of firms to influence the actions of officials (e.g. paying bribes or spending time with officials). Rather than coping with the application of (more or less favorable) rules, firms face deals. And the larger the gap between the de jure and de facto outcomes, the greater the potential space for deals, and indeed, the more prevalent are bribes.

However, striking a deal does not assure a favorable outcome. Deals themselves create uncertainty to a differing extent depending on whether deals are credible and honored by both sides, and whether these deals are open to all firms or only open to firms with certain characteristics or connections. If all firms had access to an ordered, open deal, there would be little variation in outcomes, with times clustered around the deal outcome and the ‘no-deal’ outcome for those that refused to take part in paying for the facilitation. The variation in officials’ policy actions itself indicates deals are not available to all firms on the same terms. And this in turn helps explain why the majority of firms complain about policy uncertainty and discretion of officials enforcing regulations.

Uncertainty or variations in officials’ actions are correlated with lower firm employment growth – more so, in fact, than the average level of policy outcomes in a location. Variations in implementation also skew relative growth rates across firms; favored firms grow relatively faster in sectors that interact more with the government in locations (countries or sub-national regions) with greater variation in implementation.

The burdens and impact of regulations go far beyond formal requirements. These results show that how they are (or are not) implemented across firms and their broader governance environment is much of the story. That few firms face the formal burdens – or even the same burden as other nearby firms – provides additional support for reducing excessive regulatory requirements. Requirements that are not implemented open the door to corruption, undermine government’s credibility, thwart the public interest they were supposed to serve, and may undermine support for reforms by creating opposing interests between favored and non-favored firms.

Comments

This is a very informative blog post and a great research paper, congratulations!
We have argued in a similar way regarding the gap between de jure regulation and their de facto implementation in the "Seven theses on Doing Business". http://www.die-gdi.de/CMS-Homepage/openwebcms3.nsf/(ynDK_contentByKey)/ANES-7VSG3L/$FILE/Seven%20theses.pdf
What can be done? Is focusing on reducing regulatory requirements at all a good strategy to support private sector development in countries where bureaucracies are not working efficiently or are even benefiting from excessive regulation if this makes rent-seeking through informal deals with businesses possible?
Considering the political economy of regulatory reforms it seems to me rather unlikely that these reforms will be successful in such an environment. Transforming a rent-seeking culture to a culture of service delivery requires a complex approach, rather technical reforms of regulations will probably not tackle this problem.